HIGH LOW METHOD ACCOUNTING: Definition, Formula & Examples

Some popular methods are the scatter plot method, accounting, and regression analysis. High Low Method provides an easy way to split fixed and variable components of combined costs using the following formula. High Low Method is a mathematical technique used to determine the fixed and variable elements of a historical cost that is partially more detailed update fixed and partially variable. One potential issue with the basic approach to the high-low model is that it is vulnerable to outlier data. This can be addressed by hygiene-checking the data before it’s used for the calculation. If the business is established, this could be done by comparing the same time period in different years.

The Total cost refers to a summation of the fixed and variable costs of production. Suppose the variable cost per unit is fixed, and fixed costs at the highest and lowest production levels remain the same. In that case, the high-low method calculator applies the high-low method formula to evaluate the total costs at any given amount of production.

The main benefit of the high-low method is that it is simple to implement. Since you have the total cost equation now, you can use this to calculate your cost any month. There are also other cost estimation tools that can provide more accurate results. The least-squares regression method takes into consideration all data points and creates an optimized cost estimate. It can be easily and quickly used to yield significantly better estimates than the high-low method. It also takes into account outlier numbers to assist refine the results.

• Cost management allows us to forecast future expenses and plan accordingly.
• Simply multiplying the variable cost per unit (Step 2) by the number of units expected to be produced in April gives us the total variable cost for that month.
• Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos.
• While it is easy to apply, it can distort costs and yield more or less accurate results because of its reliance on two extreme values from one data set.

The high-low method is a simple technique for determining the variable cost rate and the amount of fixed costs that are part of what’s referred to as a mixed cost or semivariable cost. The high-low method is an accounting technique that is used to separate out your fixed and variable costs within a limited set of data. For instance, the factory got a monthly production capacity of 10,000 units and paid USD 10,000 per month. However, the company needs to produce 15,000 units in some particular month.

What is the High-Low Method in Accounting?

Because of the preceding issues, the high-low method does not yield overly precise results. Thus, you should first attempt to discern the fixed and variable components of a cost from more reliable source documents, such as supplier invoices, before resorting to the high-low method. The main disadvantage of the high-low method is that it oversimplifies the relationship between cost and production activity by only taking the highest and lowest data points into account.

Hence, the remaining balance of the numerator is the variable cost of differential 4,000 units. Hence, when we deduct USD 45,000 in USD 55,000, the fixed cost is net and the variable cost to the extent of equality in the level of production is eliminated. In other words, as fixed cost is the same in both months, the fixed cost has been eliminated by deduction. Multiply the variable cost per unit (step 2) by the number of units expected to be produced in May to work out the total variable cost for the month. It involves determining the highest and lowest levels of activity and comparing the overall expenditures at each level. In most real-world cases, it should be possible to obtain more information so the variable and fixed costs can be determined directly.

Semi-variable cost

Hence, once the limit of normal production capacity is reached, the company has to incur another fixed cost irrespective of additional units to be produced. Hence, the numerator is left with the variable cost of the differential units, and when the variable cost of differential units is divided with differential units it results in variable cost per unit. Let’s understand this procedural format of the concept with the following example.

High-Low Method Calculator

Although the high-low method is designed to be used to calculate costs at maximum and minimum output, the formula can be used for any level of output. It can be useful to apply the formula to different levels of production if any of your variable costs increase in a non-linear way. This is standard practice with costs that relate to contracts for goods or services. The division of differential cost with the differential level of activity results in the variable cost per unit. So, the differential cost of USD 10,000 divided by differential units of 4,000 results in USD 2.5 per unit (10,000/4,000). Similarly, the variable cost of producing 10,000 units has been deducted from the total cost of USD 55,000 at the higher level of activity.

The issue of outlier data

Cost behavior describes how costs change as a result of changes in business activities. For example, the electricity cost for a firm will increase when working hours are increased. Cost management allows us to forecast future expenses and plan accordingly. It also aids in the control of project costs and the pre-determination of maintenance costs. We can examine long-term company trends and achieve the business goals with proper cost management.

A cost is an expense needed to sell, create or acquire assets for a product or service. In other words, it is the monetary value of expenditure for supplies, services, etc. For example, if the cost of a liter of milk is $2, the consumer has to spend $2 to acquire a liter of milk.

Management accounting involves decision-making, planning, coordinating, controlling, communicating, and motivating. Similar to management accounting and financial accounting, there is cost accounting to determine the cost of a product. Variable costs are expenses that change depending on the quantity of production or number of units sold.

High-low method is a method of estimating a cost function that uses only the highest and values of the cost driver within the relevant range. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling. The high-low method is easy to use, understand, and quick to work around. Although this is a really easy and understandable method, there are a few shortcomings to this method that make it less practical.

Since we have established that $15,000 of the costs incurred in July were variable, this means that the remaining $20,000 of costs were fixed. The high-low method is relatively unreliable because it only takes two extreme activity levels into consideration. The high-low method is a simple analysis that takes less calculation work.